One of the most remarkable British movies of the past couple of years, Berberian Sound Studiois a psychological thriller set entirely in the Kafkaesque offices of a sleazy Italian film company in the 1970s. It brings together a gifted trio of independent British film-makers: producer Keith Griffiths, who has been behind a dozen or more daring, offbeat pictures, including most recently the Cannes Palme d'Or winner Uncle Boonmee Who Can Recall His Past Lives; the cinematographer Nic Knowland, whose numerous credits since the late 1970s include Tony Palmer's Shostakovich biography Testimony and the Quay brothers' Institute Benjamenta; and writer-director Peter Strickland, a truly European director who made his feature debut in Hungary three years ago with Katalin Varga.

The low-budget Katalin Varga, shot in Romania in Hungarian, tells the story of a peasant woman embarking on a Virgin Spring-style revenge trip around the Carpathians after being banished from her native village. The most notable feature is its complex soundtrack combining electronic music, an indecipherable chorus of human voices, and slightly heightened natural sounds of wind, water, thunder and the rustling of grass and leaves. This is important because in Strickland's second film, Berberian Sound Studio, the protagonist is a shy, nondescript British sound expert, and he has two cinematic predecessors. In Francis Coppola's The Conversation (1974), Gene Hackman played a San Francisco surveillance expert hired to make secret recordings of conspiratorial lovers, who gets out of his depth and descends into paranoia. In Brian De Palma's Blow Out (1981) John Travolta had one of his best roles as an ace sound-effects man working on a low-budget horror flick in Philadelphia who stumbles across a political conspiracy. He ends up recording the screams of a dying woman and uses them to dub a slasher film.

Coppola and De Palma were of course influenced by Antonioni's Blow-Up (1966), and Strickland refers specifically to Ingmar Bergman and David Lynch in Berberian Sound Studio. The short, balding Toby Jones, one of the cinema's finest character actors at work today, plays the middle-aged Gilderoy, a home counties dork from Dorking brought to Italy to construct a soundtrack. His speciality, according to a persuasive clip we're shown, is providing the natural sounds of winds, birdcalls and rippling brooks for British natural history films. They're narrated by plummy-voiced actors with snatches of Vaughan Williams's TheLark Ascending in the background. The Berberian Studio specialises in something different: the stylish, sadistic, sexually explicit horror movies of the 1970s known as "giallo" because of the garish yellow-covered paperbacks from which they were adapted; these were especially associated with such directors as Mario Bava, Luciano Ercoli, Lucio Fulci and Dario Argento. Gilderoy's encounter with a sullen, aggressive, dark-haired beauty at the reception establishes the unwelcoming, mysteriously foreign nature of the place, as well as his identity as an innocent, unworldly mother's boy. He starts off making the first of many unsuccessful requests for his airfare, a decreasingly unfunny joke as the movie goes on.

The prissy Gilderoy is at first surprised and intrigued by this giallo world. We see the graphic red and black credit titles of "The Equestrian Vortex" depicting satanic scenes preceding the outrageous movie that the menacingly flamboyant, flashily dressed and extravagantly coiffed producer Francesco Coraggio and the director Giancarlo Santini have made. But only through Gilderoy's eyes do we experience the outrageous horrors (rape, mutilation, torture and terror) for which he must provide sound effects as well as recording the dialogue and screams of the attractive young starlets in their cramped sound booth. He keeps in touch with Dorking through his mother's letters of village activities, and is flattered by the significance attached to his contribution by his new employers and the attentions of the attractive actresses. His absorption in special effects (sizzling fat to accompany a red-hot poker penetrating a nun's vagina; a crushed marrow to capture the final sound of a plummeting body) keeps their true nature at bay. But gradually the deference of producer and director turns into contempt, especially when they take personally Gilderoy's criticisms of the studio's penny-pinching equipment, and when he dares to impugn the integrity of their artistic vision.

Jones, Strickland and the cinematographer Knowland brilliantly capture the hermetic atmosphere of a place where it's impossible to tell day from night. A pervasive mood of exploitation and corruption seeps from the films being made into the relationships between everyone involved in their making. First gradually, then suddenly, Gilderoy becomes a part of this nightmare factory and its product. He's unable to distinguish between the vicious fantasies he himself has helped create and so-called reality, and we come to realise that his carefully protected home counties existence is itself an idyllic fantasy.

Strickland is clearly making a moral judgment on film-making and popular culture, but it's more than a little ambivalent, and he's also fascinated by the process of creation, representation and self-deception. There are wonderfully funny scenes and rather beautiful moments like the one in which Gilderoy proudly exhibits his skills by creating the sound of a UFO with a wire brush during a candle-lit power failure, a sequence that resembles a painting of an 18th-century scientific experiment by that master of light, Joseph Wright of Derby. If you sit through the final credits you'll read that Suzy Kendall, one-time wife of Dudley Moore, is listed as "special guest screamer". Kendall appeared in several 1970s horror flicks, most famously Dario Argento's seminal giallo classic, The Bird With the Crystal Plumage (1970).